Russia reviews double tax treaties

As we have already informed, on March 25, 2020, President of Russia Vladimir Putin instructed the Russian Government to arrange for updates to Russia’s double tax treaties (DTTs) with “certain” countries to change how dividends and interest are taxed.

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Vladimir Putin announces major tax changes

On March 25, President of Russia Vladimir Putin made a special address to the nation in connection with the difficult epidemiological and economic situation in the country caused by the spread of the COVID-19 coronavirus.

Among other things, he said in the address that voting on the already adopted amendments to the Russian Federation Constitution would be postponed indefinitely and that state social support measures for the population and small and medium business would start to be implemented. He also announced major tax changes.

Small and medium business

The following tax support measures were proposed to prevent mass layoffs: 

– Deferral of all taxes other than VAT for the next six months (and an additional deferral on social insurance contributions for microenterprises)

– A reduction in the total amount of social insurance contributions for employees receiving higher than minimum wage salary

It seems the second measure is intended not only to temporarily lighten the tax burden on small and medium enterprises, but also to stimulate recovery from the so-called gray area.

Payment of income abroad

One recommended source for replenishing the budget to implement anti-crisis measures is the introduction of stricter taxation of funds moved out of the country by Russian residents.

As stated in the address, various tax optimization schemes result in more than two thirds of all payments of income from Russia abroad (to offshore jurisdictions) being taxed at an actual tax rate of only 2%. In order to make taxation more “fair,” the president proposed setting a tax rate of 15% on dividends payable abroad.

It should be noted that in Russia the current standard tax rate for dividends received by a foreign company is already 15% unless double tax avoidance treaties (“DTT”) apply.

Moreover, there are several mechanisms simultaneously in effect and aimed at combating the use of lower rates in various “optimization schemes,” for example:

  • The beneficial owner concept which, when applied, allows the tax authorities to win more than 90% of litigation on this subject and assess additional tax at the source at the 15% rate
  • The “unjustified tax benefit” concept. Applying this concept allows the tax authorities to requalify various types of payments to foreigners into dividends or simply a donation, with the income being taxed at the source in Russia.

It is also anticipated that in 2021 the Multilateral Convention to Implement Tax Treaty Related Measures to Prevent Base Erosion and Profit Shifting (the Multilateral Instrument or MLI) will start to be applied. The MLI is designed to add to majority of effective double-tax treaties a principal purpose rule (principal purpose test) that also prevents benefits from being applied if getting those benefits was one of the principal purposes of any structure or transaction.

However, in his speech the president did specifically instruct the government to arrange for updates to Russian DTTs with “certain” states. The president also voiced the ultimatum that Russia could unilaterally withdraw from DTTs if the relevant changes to the treaties are denied by the counterparties.

Considering the mechanisms already in effect now, it isn’t entirely clear in what format and precisely how this proposal will be carried out.

If we take the address literally, the president most likely meant that negotiations need to be held on updating DTTs only with those countries that mainly service Russian capital, for example, with Cyprus, the Netherlands, Luxembourg and other jurisdictions popular for tax planning. Introducing a 15% fixed tax rate on dividends will make it possible to “close the issue” with such countries and lighten the burden on the Russian tax authorities for tax administration of payments to the companies incorporated in those jurisdictions. Such measures, however, do not take into account that there are real businesses also operating in those countries that will be endangered.

It is also possible that stricter taxation will affect not only dividends, but also other payments to such jurisdictions (the address clarified that payment of interest is also understood to be payment of income).

Finally, there is no reason to believe that more respectable jurisdictions will “suffer.”

On the other hand, it is not unthinkable that some radical steps will be taken and the fiscal relationships with certain countries will be entirely broken off.

The measures described above could not only considerably increase the tax burden on business, but also lead to a significant flight of foreign capital from the Russian economy and a deterioration of relations between Russia and those countries with whose DTTs changes are proposed. This is particularly the case if relations are broken off with them (which will translate into having no mechanisms for avoiding double taxation both for Russian entities and individuals doing business abroad or receiving income from abroad, and for foreign entities and individuals in a similar situation).

The number of possible tax authority claims and cases of recharacterizing intragroup payments (royalties, charges for intragroup services) as dividends could also potentially go up. There could also be more claims when the pass-through approach is used. Therefore, we recommend preparing a defense for potential issues of concern in advance.

It is equally possible that, on the contrary, everything will stay close to how it currently is (in other words, some minor steps will be taken to work with DTTs, such as negotiations, to ensure they do enough to combat tax abuses).

Personal income tax on individuals’ interest income on capital exceeding RUB 1 million

Following other countries’ example, in order to replenish the budget, it was proposed to charge the standard 13% personal income tax rate on interest received by individuals from bank deposits or investments in debt securities. The president made assurances that this change will affect not more than one percent of depositors, and only the interest income from the capital invested in those assets will be taxed if the invested capital itself exceeds RUB 1 million. We remind you that the Russian Tax Code currently stipulates that a tax base for personal income tax on interest income arises only if the interest rate on the deposit exceeds the Russian Federation Central Bank key rate by five percentage points (9% for foreign currency deposits) regardless of how much capital is invested. Earnings on government securities are entirely exempted from personal income tax, as are coupons on bonds from Russian issuers in rubles issued after January 1, 2017, up to the Central Bank key rate +5 percentage points.

Thus, the president’s assertion that after the change is made “the terms for depositing funds in Russian banks will continue to be attractive and some of the highest yielding in the world” seems far from obvious. And the claim that it will affect only one percent of depositors cannot be viewed as anything other than a veiled proposal to the well-off members of society to fund the budget’s social obligations indefinitely. An offer that cannot be refused…

Dentons’ Tax practice has extensive experience advising and supporting international tax disputes with the tax authorities and is prepared to provide practical assistance in resolving these issues.

Tax major changes in Russian legislation and practice for the second half of 2019

Dentons’ lawyers have prepared an overview of tax major changes in Russian legislation and practice for the second half of 2019

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Finance Ministry proposes confiscating funds illegally moved offshore

We already presented our vision of general trends in the taxation of intragroup services in our alert on the most important tax events for the first half of 2019. Until recently the tax authorities have followed the main two lines of attack: (1) challenging expenses on the grounds of insufficient documentary support and (2) requalification of remuneration for services in other types of income (generally dividends).

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Changes to currency regulation rules for individuals

On 2 December 2019, the President of the Russian Federation signed Federal Law No. 398-FZ (“Law No.398-FZ”) which made the latest significant amendments to the Federal Law on Currency Regulation and Currency Control (the “Currency Regulation Law”). The amendments, that were adopted, will affect individuals who are currency residents of Russia (“Residents”) and have accounts at foreign banks.

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Changes to currency regulation rules for individuals

On August 2, 2019, the President of the Russian Federation signed Federal Law No. 265-FZ (the “Law”) amending the Federal Law on Currency Regulation and Currency Control (the “Currency Regulation Law”).

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Russian VAT on e-services: Breaking news

As you know, under the Russian Federal Law No. 335-ФЗ of 27.11.2017 all foreign e-services providers must register with the Russian tax authorities and pay Russian VAT themselves. This has given rise to many questions and technical difficulties. On 24April 2019 the Russian Federal Tax Service (“FTS”) issued the long-awaited guidance letter No. СД-4-3/7937@, where they attempted to adequately address these issues. The major conclusions discussed in the letter can be summarized as follows:

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